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The US dollar and yen remain
soft. The news stream has encouraged the so-called risk-on
trade. The Greek debt buyback appears to have gone
well enough that it will get dollop of aid. Spain
reportedly received 40 bln euros of bank aid. There seems
to be a potential compromise banking supervision in Europe.
On top of that, of course, the market expects the Federal Reserve
to announce an expansion of its quantitative easing later today
and keep the door open to further steps if necessary. The dollar made new eight month highs against the yen,
just shy of the JPY83 level. These dollar gains
ahead of the FOMC meeting underscores one of our interpretative
points that the old drivers of dollar-yen, like interest rate
differentials and general risk appetite, have broken down,
trumped by Mr Abe and his aggressive monetary and fiscal
rhetoric.

We would discount speculation of covert intervention and instead
point to polls showing that not only will the LDP win this
weekend's election, but it is within striking distance of
securing a 2/3 majority (of the 480 seats in lower chamber of the
Diet). We note that although the October core machinery
orders recovered after falling sharply in August and September,
the 2.6% rise was less than expected and this reinforces
speculation that the BOJ can expand its asset purchase program as
early as next week--which would be the third expansion in four
months--and this is before the new government implements its
changes.The euro's recovery from the $1.2880 low at the start of
the week is impressive. Developments are
conspiring to keep the tail risks at bay. It may not have
been very pretty, and the burden fell on Greek banks, but the
bond buy back has been sufficiently successful. Greek bonds
have continued to rally, with the10-year yield off another 62 bp
to 12.58%, seemingly rewarding those investors most who did not
participate (rewarding defectors in game theory), which now
appear to be only officials and foreigners. Spain received
the funds for its bank recapitalization scheme. As part of
the conditionality, look for the troubled banks to sell non-core
assets (including corporate holdings) and close branches, laying
of employees. In addition, they will transfer assets to the
"bad bank". The mechanism was established in haste and the
pricing of the "toxic assets" seems problematic and something
that may come back to bite.
Turning to Italy, the market seems to find solace in the idea
that Berlusconi may not win and Italian yields are down for the
second consecutive session, though that 4.66% the benchmark
10-year yield is above last week's close of 4.51%. A poll
in La Stampa today shows that given the choice between Monti,
Berlusconi and Bersani (leader of the PD), Monti is favored by
47%. However, Berlusconi polls 24% compared with Bersani's
20%. And Monti has been cagey about whether he will run,
though he has denied such intentions in the past. Bersani
advised against, but of course that is narrow self-interest. Look
for this issue to become more salient. The UK's labor report was stronger than expected and this
is helping sterling keep pace with the euro's
advance. The claimant count fell 3k, whereas the
consensus expected a 7k increase and the Oct count was revised
slightly lower. Unemployment was unchanged at 4.8%.
The fact that the UK's employment data has held up better than
the economy raises questions about productivity that will be a
key discussion and research point. The key event of the North American session is the
outcome of the FOMC meeting. The Fed's
communication is sufficiently transparent that nearly every one
expects an expansion of QE3+ today as purchases being conducted
under Operation Twist get replaced by outright purchases.
New economic forecasts and a Bernanke press conference will also
be featured. While it is possible the Fed announces that it
will increase QE by $45 bln a month, which is to roll the entire
long-term Twist purchases into QE, which would more than double
its size and much more on a duration adjusted basis.
We suspect there is a greater than appreciated risk that
the Fed does not double up, but instead increases QE more
modestly by $20-$25 bln a month and keeps the bar low for
expanding it further.
Lastly we note that since
QE3 was announced, the dollar is broadly mixed, but slightly
higher overall. Many key commodity prices, including gold
and and oil are lower. The S&P 500 is slightly lower.
The 10-year Treasury yield is a few basis points
lower.